The Surprising Shift in Multifamily: Affordability Takes a Backseat as New Risks Dominate 2025, Say Origin’s David Scherer and Madera’s Jay Parsons

Affordability Reclassified as Tailwind Rather Than Headwind For Investors

CHICAGO (December 18, 2024)—Higher-for-longer interest rates, labor shortages, regulatory concerns and the impact of proposed tariffs are edging out affordability as the greatest threats to the multifamily sector moving into 2025. With wage growth currently outpacing inflation, industry experts are characterizing affordability as a tailwind instead of a headwind. Finally, among the most notable surprises of this year that are shaping 2025 are tenant retention levels.

David Scherer, Co-CEO, Origin Investments, and Jay Parsons, Principal and Head of Investment Strategy, Madera Residential, contributed those comments in “Looking Ahead to 2025,” a webinar hosted by Origin Investments. Scherer and Parsons discussed the outlook for multifamily investment including issues not getting enough attention, looming risk factors, and the headlines that are most likely to surprise in 2025.

Risks on the Horizon

Scherer and Parsons noted the risk to multifamily valuations and transaction flow if interest rates remain elevated. “A higher-for-longer interest rate environment means lenders will be far less inclined to extend current loan agreements. That makes me a little nervous because of the impact it will have on valuations,” Scherer said. “Quality sponsors are affected by the bad decisions others make.”

Other risk factors are the impact of potential tariffs and labor shortages that could put upward pressures on construction costs, and new regulations that could put greater restrictions on GSE lending sources such as Fannie Mae and Freddie Mac.

Scherer noted that policies focused on tariffs and labor shortages likely will have an impact on construction pricing in 2025. Origin is projecting construction rate increases of as much as 8% to 10% in markets such as Dallas and Phoenix, with 3% to 5% increases in other markets. This is a notable upward swing, as construction pricing had dropped by 3% to 5% on average in 2024.

Parsons noted another short-term concern remains high borrowing costs limiting transaction volumes – making it harder for investors to deploy capital.

A Tailwind for Multifamily

While most housing cost discussions are about unaffordability for home buyers, Parsons noted the difference for multifamily investing. “Affordability is a bifurcated issue. For market-rate, investment-grade apartments catering to middle- and upper-income renters, affordability is a tailwind, not a headwind,” he said, noting that the U.S. has experienced nearly two years of wage growth eclipsing rent growth. “Rent-to-income ratios are trending back to pre-Covid, pre-inflation levels.”

A significant element of the positive rent growth story is the tailwinds at the top of the market for Class A and B rentals. “We have some challenges in the sector,” Parsons said. “But it’s generally not in investment-grade Class A/B multifamily properties.”

For Scherer, the impact of government regulatory efforts at the local or state level doesn’t get enough attention. “The entitlement and approval processes are time-consuming and taking longer and longer to navigate,” he said. “Those programmatic delays and other factors have created the perfect storm that has contributed to the housing supply shortage.”

Parsons agreed and noted that while President-elect Trump has talked about streamlining building approval processes, the federal government has little power to intervene.

2025 Headlines … The Sure and Not Surprising

Multifamily is one of the most dynamic sectors in commercial real estate investment. With optimism generally strong, the sector is poised to make headlines in 2025. For Scherer and Parsons, the surest headlines will be focused on market fundamentals—rents and supply. Other headlines that wouldn’t be surprising to either include the burn-off of rent concessions and rent growth levels outpacing the rate of inflation.

Scherer’s surest headline underlines the fundamentals of supply and demand. Many regions of the country will return to historic norms of 3% rent growth, with high-growth markets increasing more than double that amount. Scherer expects that rent growth will exceed the rate of inflation, which will be “sticky at between 2.5% and 3%.”

“The bond markets will become increasingly more uncomfortable under that scenario,” Scherer said. “The expectations that inflation will miraculously drift to 2% aren’t likely, especially with positive rent growth. I believe we are in the beginning stages of a secular bull market for rents which will be recessionary for years,” he concluded.

Parsons expects the drop off in apartment supply to be one of the top headlines in 2025.

“The fall-off in new product delivered is significant and will be a recurring discussion point throughout 2025,” Parsons said. He noted that the shift has been significant, from record high levels of starts and deliveries beginning in 2021, to dramatic and historically low levels projected for the next few years.

“This notion of supply decreasing, this isn’t conjecture. We know how much supply is coming,” Scherer said. The increase in interest rates that dampened new development means that “we lost two years of starts that should have happened.”

A common question, according to Parsons, is whether the construction slowdown is a temporary pause or a long-term dynamic. The American Institute of Architects maintains an index on billings which occur long before there is a planned start. Those billings, already low last year, are continuing to trend downward. That in turn leads to fewer permits being issued. Further, the Federal Reserve Senior Loan Officer survey shows banks haven’t loosened standards for construction loans, nor has borrower demand picked up.

Parsons also said we could see concession usage materially decline in 2025. It hasn’t been uncommon for landlords to offer 2-3 months of free rent in some high-supplied areas. With deliveries slowing down and new apartments leasing up, apartment owners could pull back on the use or value of rental discounts.

A 2024 Surprise

One of the biggest surprises that emerged in 2024 was the high renter retention level in many markets across the country.

In 2024 the market experienced a 50-year high in supply, which translated to rent cuts and concessions. In that kind of environment, the expectation is that people will do what is in their economic best interest: find the better deal. Yet increasing numbers of people chose to renew leases, and retention rates actually increased.

“For most renters, the depth of rent cuts wasn’t significant enough to drive people to try to save a few dollars and take on the fractional cost of relocating,” Parsons said. “At the same time, property managers across the industry put a heavy focus on resident retention and occupancy. When renters got renewal offers with minimal or normalized renewal increases, a lot of renters said, ‘That’s a good deal. I’m willing to pay that and stay put.’”